Here Are The Problems With Jeremy Grantham's 'Road To Zero Growth' Argument

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The vigorous global economic growth of the last two centuries is over, according to Jeremy Grantham and Robert Gordon. That prediction, if correct, has profound and worrisome implications for investors. And the short-term trend is indeed disquieting: Growth has been close to zero over the last decade in advanced countries. But the most likely outcome is that per capita GDP growth going forward will approximate its U.S. historical average of 1.8%, and it will grow faster in developing markets.

Gordon, a highly distinguished Northwestern University economist with a lifelong interest in productivity growth, recently published a paper, Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds, in which he argues that the revolutionary innovations that have driven past growth are not likely to be repeated any time soon. Even more recently, Jeremy Grantham, who has previously argued that increased natural resource costs are likely to choke off global growth, published his quarterly commentary, which supported and extended Gordon's position, with his characteristic focus on resource constraints.

Gordon identified six headwinds, mostly having to do with growth in the United States, which represents 5% of world population. And, indeed, if you only care about people in the United States, these are troubling times. These troubles will pass, but not before wrenching adjustments are made to education, entitlements, and industrial structure.

But the outlook for the developing world has never been better, a prospect to which Gordon gives insufficient weight.

Let's consider Gordon's headwinds - and why I believe he has overstated the dangers that they pose to growth. I'll then turn to Grantham's arguments, and conclude with an optimistic forecast for global GDP.

The three industrial revolutions and the growth of real per-capita GDP

Following convention, Gordon attributed the productivity surge of the last two and half centuries to three distinct Industrial Revolutions. The first saw the introduction of the cotton gin, the mechanized loom, the steam engine, the railroad, and the factory system. Gordon dated this first revolution to 1750-1830. (I use slightly different dates, 1776-1826.) The second revolution ran from about 1876 to 1926 (my dates this time) and saw the invention of the telephone, audio and video recording and playback devices, electrical appliances, the delivery of electric current to businesses and households, the automobile, the airplane, radio, and the first flickers of television. The third epoch of innovation was the computer and Internet revolution. For the sake of data analysis, I'll say it started in 1976, when both Microsoft and Apple were founded, although Gordon argued, with some validity, that much of the benefit of computers came earlier.

At any rate, the dates I've chosen break up American history into 50-year periods, limited only by data availability, thus reducing the temptation to monkey with the data periods to get a desired result.

Figure 1 shows the growth rate of real per capita GDP in the United States over the full period considered and each of the subperiods - all three revolutions, plus the interim periods between them - although the first few years' data are missing.1 While the growth rate looks almost constant in Figure 1, breaking the time into subperiods reveals considerable variation in growth rates, and the recent (post-2000) stagnation has been dramatic. Nevertheless, the average growth rate during industrial evolutions, 1.84%, is essentially identical to the average growth rate between the revolutions, 1.85%.2 Note that we've examined U.S. data for lack of anything better before about 1950; the relevant growth rate is for the world, because investors can hold global portfolios that take direct advantage of worldwide GDP growth.

While the almost-exact equality of within-revolution and between-revolution rates is purely a coincidence due to the dating used, the lack of a relationship between industrial revolutions and growth rates calls out for explanation. My conjecture is that it takes a long time for cutting-edge, productivity-enhancing technology to be absorbed into the general economy, causing the benefits of a given industrial breakthrough to be spread out over generations or even centuries. It is said, for instance, that half the world's population has never made a phone call.3 If this is even approximately true, the world is still experiencing welfare gains from the adoption of a device invented 136 years ago. No wonder industrial revolutions don't line up neatly with periods of rapid GDP growth!

Another example of this principle, cited misleadingly by Gordon, is transportation speed. The speed at which passenger travel occurred, he writes, "increased steadily until the introduction of the Boeing 707 in 1958. Since then, there has been no change in speed at all, and, in fact, airplanes fly slower now than in 1958 because of the need to conserve fuel." This observation misses the point. We know perfectly well how to fly at three times the speed of sound, and the military does it every day, but it's fuel-intensive and costly. We've chosen not to spend valuable resources on faster passenger travel. It's fatuous to think we never will or never could.

We should thus expect the dissemination of already-invented technology to be reflected in world GDP growth well into the next century. There will undoubtedly be more technological innovation, but we do not need to have another industrial revolution to get meaningful increases in the global standard of living. (That said, we may well be in the beginning stages of a biotech revolution, one that will continue to improve health outcomes and make the global food supply cheaper and more varied than it is now.) What we do need is continued improvement in efficiency - doing more with less, making existing resources work harder, finding new resources to replace those that become scarce and expensive, and creating new human capital through education that fits the skills that the future will require.

Robert Gordon's six headwinds

Gordon's essay is skillfully argued, offering many illuminating facts about the profound change in the daily lives of ordinary people between, say, 1870 and 1950. Having made the transition from a relatively primitive way of life (in which, for example, women spent much of their day carrying water) to a modern way of living, we cannot experience the same transition again, he argues.

There is something to his claim. Another 50-fold increase in the U.S. standard of living over the next 250 years is not in the cards. I agree with Gordon that the second industrial revolution, representing the bulk of the transition from a primitive standard of living, was the most important one, and the hardest to replicate. He concluded from this fact that further improvements in the standard of living will be less profound and will have a smaller impact on per capita GDP.

Maybe the improvements will be less profound for Americans - although it is hard to foretell the distant future - but we are not the only people in the world.

There are a great many people who have barely begun to experience the second industrial revolution, much less the third. Women all over the world still carry water day in and day out. We in the developed world don't see it, except perhaps on Peace Corps assignments. As more people are liberated from the extreme effort and mental drudgery of manual labor, they need not invent new technologies to add to the growth rate of global GDP - they just need to be able to use the telephone, the automobile, the computer, and so on. A report from sub-Saharan Africa shows that the value placed by the poor on mobile phone access is so high that they are willing to forego meals to afford phone service. This is may sound like an irrational choice, but it's actually supremely rational: The transactions in which they can engage over the phone will make future meals that much more secure and affordable.

Gordon identified six headwinds for future economic growth. Let us examine why each of them is less of a global concern than Gordon suggests. (The quotations I include below are all Gordon's.)

1. "The 'demographic dividend' is now in reverse motion."

This first headwind requires some explanation, because Gordon's use of the term "demographic dividend" differs from the conventional use. The conventional demographic dividend is the increase in productivity that comes from a temporarily large ratio of workers to children-plus-retirees, which we experienced thanks to the sudden extension of life expectancy between the late 1800s and today. If people start living long enough to extend their working lives but not long enough to have much of a retirement, that boosts GDP. When the number of retired people climbs, as it has recently, the demographic dividend begins to dissipate; if people are having fewer children at the same time, the dividend may disappear entirely.

Gordon, however, treats the "demographic dividend" as a much narrower phenomenon: In his construction it was "the movement of females into the labor force between 1965 and 1990, which raised hours-per-capita and allowed real per-capita GDP to grow faster than output per hour."

The entry of women into the workforce is a second-order effect. Women have always been productive, but their production was not well-captured by GDP measures until they moved in large numbers into the paid sector.

It is not a coincidence that the period of fastest economic growth occurred when increasing life expectancy was enabling most people to live productive lives in middle age, but not allowing them to retire.

This provocative reassessment challenges us to make better use of our elderly. Most older Americans wish to be economically active in some way, but their wisdom is more valued in the marketplace when they are scarce, not increasingly abundant, as they are today. As a result, jobs that use the skills of older workers effectively have been hard to come by. The trend toward retiring gradually rather than suddenly, whether because of insufficient savings or because of a desire to remain active, may be a step in the right direction.

2. Educational attainment in the U.S. has hit a "plateau."

If one is trying to forecast global GDP, we should not be concerned about changes in country rankings. The U.S. led the second and third Industrial Revolutions, but there's a good chance someone else will lead the next one. As an American, I'm deeply concerned about the shortcomings of the U.S.'s (primary and secondary) educational system, but I'm delighted to see that Chinese, Indian, African, and Latin American people are getting a chance and doing very well relative to their own recent past.

3. Inequality is on the rise.

"The most important [headwind] quantitatively in holding down the growth of our future income is rising inequality," according to Gordon. "If what we care about when we talk about 'consumer well being' is the bottom 99 percent, then we must deduct 0.55 percent from the average growth rates of real GDP per capita presented here and elsewhere."

This amounts to a forecast that the recent increase in inequality, which dates back only to about 1980 (before that, inequality was decreasing), will continue indefinitely. Further increases in inequality (as measured by the welfare of the top 1% of the income or wealth distribution compared with the other 99%) will only occur if increases in productivity are concentrated among the top 1% or if the top 1% can somehow exploit the others unfairly, capturing others' productivity gains for themselves.4

Both seem extremely unlikely. The biggest productivity gains tend to come from people in the top 15% of the income distribution - engineers, entrepreneurs, doctors, and so forth - who may then enter the top 1%, if they can capture some of the gain. At any rate, I am more concerned about the tension between the top 15% (roughly corresponding to the intellectually gifted) and those of average or below-average ability. In a preindustrial or industrial society, the job description of "pick up this heavy object and move it over there" can be filled by the otherwise untalented. In the future, we will not need many such workers.

1. I use the United States because of the superior quality of the data for the early years. Angus Maddison has collected real per capita GDP for the world, but, despite his heroic efforts, the data are sporadic until 1950. They show that the world had slower growth than the U.S. until about 1950, then faster growth since then. See Maddison, Angus, "The West and the Rest in the World Economy: 1000-2030," World Economics, October-December 2008; underlying data are available on the web site maintained by Groningen University in memory of the late author at http://www.ggdc.nl/maddison/.

2. While the growth rate of real per capita income has slowed in the post-1976 period, the tremendous increase in the number of households over that period means that the growth rate of real income per household has not slowed nearly as much. In fact, the latter may have grown at the historical rate of 1.8%. (I don't have the data.) It takes a lot of money to support the unprecedented proportion of single adults and single parents in the population.

3. This may be apocryphal. There exist, of course, no definitive statistics on this. But, whether it's literally true or not, it certainly has - if you'll excuse the pun - the ring of truth. Kofi Annan, Al Gore, Newt Gingrich, and a number of prominent technology executives have all said it.

4. In other words, if the top 1% can arrange to pay the bottom 99% less than their marginal product. Just stating the problem this way makes such an outcome seem unlikely - 99% of the people do not work for the other 1%. About 17% work in various levels of government, and another 10% work for nonprofit organizations. Those in the private sector mostly work for corporations, the ownership of which is very widely dispersed among U.S. and non-U.S. pension funds and individual investors, and for small-business entrepreneurs whose incomes do not typically put them in the top 1%.